4 Retail-Discount Stores to Fend Off Industry Headwinds

Players in the Zacks Retail – Discount Stores industry that have been gaining amid the pandemic-led increased at-home consumption and stock hoarding are likely to witness some pullback in demand in the near term as the process of vaccination rollout has picked up pace. The ease in social-distancing norms and return to active social lifestyle are likely to build up demand for traditional categories. Apart from this, investments associated with digital fulfillment as well as high COVID-related expenses are likely to keep margins under pressure.

Nonetheless, industry participants have been focusing on deepening engagements with consumers, adding more compelling products, and enhancing digital and data analytics capabilities. Constant efforts to enhance omnichannel operations have been working in favor of Costco Wholesale Corporation (COST), Target Corporation (TGT), Dollar General Corporation (DG) and Big Lots, Inc. (BIG).

About the Industry

The Zacks Retail – Discount Stores industry comprises companies that offer apparel, accessories, footwear, beauty products, personal and baby care products, cleaning products, pet supplies, and food and beverage products. The industry participants also provide home textiles, home furnishings, housewares, toys and seasonal décor products. These companies sell their products through stores, digital channels, or both. Some of the industry players operate membership shopping warehouse clubs, offering branded and private-label products in a range of merchandise categories.

4 Key Retail-Discount Stores Industry Trends

Pandemic-Led Demand Likely to Moderate: While a number of players saw a bump in sales in most parts of 2020, the trend is likely to moderate in the near term. Notably, companies have been benefitting from burgeoning demand (especially online) for essentials due to the pandemic-induced stock hoarding and elevated at-home consumption. Incidentally, higher dine at-home and work-from-home practices boosted demand for groceries and cleaning supplies, among others. However, with the vaccination program on fast lane, consumers are likely to return to the old normal – eating at restaurants, going to office, traveling and other customary practices. This in turn will result in lower at-home consumption activities and a drop in pantry-loading trends. We believe that these factors may weigh on year-over-year sales comparisons in the forthcoming periods.

Consumers Seek Better Bargains: The strategy to sell products at discounted prices has helped industry players draw customers, who have been seeking both value and convenience. Under the current circumstances, people in the low-to-middle income groups have been showing preference for discount stores. Clearly, a differentiated product range resonates well with customers’ spending habits. Markedly, Dollar Tree, Inc. (DLTR) has introduced a Combination Store to serve small towns and rural communities. The company has been receiving favorable response from customers for the same. Meanwhile, the passing of a coronavirus relief package worth $1.9 trillion that entitles eligible Americans to $1,400 stimulus checks is likely to trigger spending across the board. Clearly, demand will not be restricted to a few categories as was noticed when the pandemic hit the economy. The ease COVID-19 restrictions, thanks to a rapid inoculation drive and the return to active social lifestyle, events and occasions are likely to spur demand for traditional categories. Ross Stores, Inc. (ROST), Burlington Stores, Inc. (BURL) and The TJX Companies, Inc. (TJX) are likely to benefit as the economy steadily returns to the pre-pandemic normal.

Digitization in the New Normal: With the change in consumer shopping pattern and behavior amid the pandemic, industry participants have been evolving to play dual in-store and online roles. In fact, the companies’ digital businesses have played a key role amid the lockdown. Apart from upgrading digitally, companies are coming up with unique products and better deals. Initiatives such as building omni-channel, coming up with loyalty and marketing programs, enhancing supply chain and providing faster delivery options, be it curbside pickup or delivery at home, are worth mentioning. Simultaneously, companies are investing in renovation, improved checkouts and mobile point-of-sale capabilities to keep stores relevant. Markedly, the COVID-19 outbreak has rapidly changed the convenience of digitization into a necessity, and companies have been taking every step to capitalize on that demand. Keeping in mind consumers’ product preferences and growing inclination toward online shopping, retailers need to replenish shelves with in-demand merchandise and ramp up investments in digitization this holiday season.

Pressure on Margins to Linger: Companies in the industry are vying for a bigger share on attributes such as price, products and speed to market. Further, the increasing dominance of e-commerce players has made the retail-discount space highly competitive. This has compelled a number of players to strengthen their digital ecosystem and boost shipping and delivery capabilities. While these endeavors drive sales, they entail high costs. Apart from these, any deleverage in SG&A rate, higher labor and occupancy costs, and increased marketing and other store-related expenses might build pressure on margins. Meanwhile, the impact of additional employee payments and benefits along with investments undertaken to preserve safety and health of customers and team members amid the coronavirus crisis cannot be ruled out. That said, sustained cost-containment measures are needed to be put in place for managing margins.

Zacks Industry Rank Indicates Dim Prospects

The Zacks Retail – Discount Stores industry is housed within the broader Zacks Retail – Wholesale sector. The industry currently carries a Zacks Industry Rank #187, which places it in the bottom 26% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since the beginning of February this year, the industry’s earnings estimate for the current year have moved down approximately 5.3%.

Despite the industry’s drab near-term prospects, we will present a few stocks that are worth taking note of. But before that, it’s better to take a look at the industry’s shareholder returns and current valuation.

Industry vs. Broader Market

The Zacks Retail – Discount Stores industry has underperformed the broader Retail – Wholesale sector and the Zacks S&P 500 composite over the past year.

Stocks in this industry have collectively advanced 47.7% compared with the Zacks S&P 500 Composite’s increase of 70.5% and the Zacks Retail – Wholesale sector’s rise of 67.4% in the said time frame.

One-Year Price Performance

Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings (P/E) ratio, which is commonly used for valuing retail stocks, the industry is currently trading at 25.67 compared with the S&P 500’s 22.58 and the sector’s 30.47.

Over the last five years, the industry has traded as high as 29.98X and as low as 17.93X, with median being at 20.55X, as the chart below shows.

Price-to-Earnings Ratio (Past 5 Years)

4 Retail Discount Stores Stocks to Keep a Close Eye On

Costco Wholesale Corporation: This Issaquah, WA-based company’s growth strategies, better price management, decent membership trends and increasing penetration of e-commerce business have been contributing to its performance. Thanks to its status of an essential retailer, the company has been benefiting from rising demand. Cumulatively, these factors have been aiding this operator of membership warehouses in registering impressive comparable sales run. Costco registered comparable sales growth of 13.8% in February. The company has been rapidly adopting the omni-channel mantra to provide a seamless shopping experience, whether online or in stores. Consumers’ increased shift to online purchasing owing to the coronavirus outbreak seems to have worked in favor of Costco. We note that e-commerce comparable sales soared 91.1% during the month of February. The company is also on path to gradually provide curbside pickup facility to customers and is currently testing the same at three stores in Albuquerque, NM. Notably, shares of this Zacks Rank #3 (Hold) company have jumped 10% in the past year. The company has a trailing four-quarter earnings surprise of 2.2%, on average. It has an estimated long-term earnings growth rate of 8.8%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price and Consensus: COST

Target Corporation: This general merchandise retailer has been making investments to enhance omni-channel capabilities, come up with new brands, refurbish stores and expand same-day delivery options to provide a seamless shopping experience to customers. Markedly, the company has been making multiple changes to its business model to adapt and stay relevant in the ever-evolving retail landscape. Target is always striving to build on its partnerships, especially with popular and high-profile brands. In this context, the company plans to open 100 Ulta Beauty (ULTA) at Target shop-in-shops in 2021, with plans to add several more over time. Also, the company is taking its long-drawn relationship with Apple Inc. (AAPL) to the next level and has introduced a new Apple shopping destination online and in 17 outlets. Target recently introduced Mondo Llama brand to reinforce its footprint in the crafting space. The company also shared plans to launch its latest food and beverage line ‘Favorite Day’ on Apr 5. Markedly, Target plans to make an investment of about $4 billion annually during the next several years to ramp up store openings and remodels, scale up fulfillment services and enhance supply chain capabilities, keeping speed and convenience in mind. Impressively, Target has a trailing four-quarter earnings surprise of 53.3%, on average. The company has an estimated long-term earnings growth rate of 10.2%. We also note that shares of this Zacks Rank #3 company have surged 78.4% in the past year.

Price and Consensus: TGT

Dollar General Corporation: Better pricing, private label offerings, effective inventory management and merchandise initiatives have been aiding this Goodlettsville, TN-based company’s performance. These along with focus on consumable and non-consumable categories with impressive same-store sales run are noteworthy. The company has also been offering “better-for-you” products at affordable prices. Additionally, it has been expanding cooler facilities to drive the sale of perishable items. Moreover, initiatives such as DG Pickup and DG GO! mobile checkout are aimed at providing convenient and contactless shopping experience. Impressively, shares of this Zacks Rank #3 company have advanced 31.1% in the past year. The stock may scale new highs with solid prospects, brand recognition and strategic endeavors such as the new store concept, popshelf. Notably, the company has a trailing four-quarter earnings surprise of 24.6%, on average. It has an estimated long-term earnings growth rate of 13.7%.

Price and Consensus: DG

Big Lots, Inc.: This Columbus, OH-based company has managed to stay afloat in a tough retail landscape on the back of prudent operational strategies as well as omni-channel strength. During fourth-quarter fiscal 2020, Big Lots delivered comparable sales growth of 7.9%. The company is experiencing strong e-commerce growth, buoyed by the success of the “Buy Online Pick-up In Store” functionality. Markedly, during fiscal 2020, the company introduced curbside pickup, same-day delivery in partnership with Instacart and same-day delivery with biglots.com with pickup. The company has been gaining from its transformation initiative, referred to as Operation North Star, which encompasses driving top-line growth, cost containment, and enhancement in systems and infrastructure. Speaking of Lot and Queue Line programs, given its success in fiscal 2020, management plans to roll out the program across additional stores in fiscal 2021. Notably, the company plans to expand offerings under the Broyhill brand. We note that shares of this Zacks Rank #3 company have soared more than 500% in the past year. Also, the Zacks Consensus Estimate for its current-fiscal EPS has risen 3.7% in the past 30 days. Impressively, the company has a trailing four-quarter earnings surprise of 57.3%, on average. It has an estimated long-term earnings growth rate of 11.2%.

Price and Consensus: BIG

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